Federal Reserve Chairman Alan Greenspan said yesterday he sees no sign that inflation is about to get worse, but he nevertheless signaled it may be time to nudge short-term interest rates higher to prevent the economy from overheating.
At times over the past two years, Greenspan had resisted calls from other Fed policymakers to raise rates to head off an increase in inflation. Yesterday, he indicated that with the nation's unemployment rate now down to a near-three-decade low and the economy still booming, he would like to see growth slow soon.
The bond market staged a strong "relief" rally after Greenspan spoke despite the widespread assumption that Fed policymakers would raise their 4.75 percent target for overnight interest rates by a quarter of a percentage point at the end of this month. The relief came from Greenspan's moderate language, which suggested that any action on rates would be limited, perhaps to a single increase this month rather than a series of increases in coming months, analysts said. Yields on 30-year U.S. Treasury bonds fell to 5.96 percent, from 6.06 percent at Wednesday's close. Stocks were little changed.
Although the nation is enjoying a "stellar noninflationary economic expansion," Greenspan told Congress's Joint Economic Committee, "there are developing imbalances" that might put the expansion at risk. His key concern, Greenspan said, is that the economy has been growing about 4 percent annually for several years, a pace that has been fast enough to steadily reduce the number of workers who don't have a job but would like to find one. By last month the national unemployment rate was down to 4.2 percent.
"Should labor markets continue to tighten, significant increases in wages, in excess of productivity growth, will inevitably emerge" and lead to higher inflation, Greenspan warned.
But the Fed chairman has been issuing that same warning for two years without raising rates. And while he stressed that "when we can be preemptive we should be," Greenspan also said, "But this may not always be possible -- the future at times can be too opaque to penetrate."
With such opaque language, some analysts and even a Fed official or two noted that his testimony didn't rule out a decision at the next Fed policymaking session, June 29-30, to defer a rate increase until later in the year.
For the first time, Greenspan indicated specifically that he would like to see economic growth slow only modestly, to around 3 percent a year. With the working-age population increasing about 1 percent a year and labor productivity -- the amount of goods and services produced for each hour worked -- rising about 2 percent, the economy can grow at a 3 percent pace without causing labor markets to become even tighter and put pressure on prices, he explained.
Greenspan said the higher growth rate enjoyed in recent years "represents an unsustainable trend" produced because consumers and businesses have been increasing their spending faster than their regular incomes have been rising. The added spending has been spurred by the capital gains generated by the stock market boom and rising home prices, he said.
While the Fed chairman and many of his colleagues undoubtedly would like to see stock prices either stabilize or perhaps even retreat somewhat to remove that "spur," he made clear in his testimony that the Fed doesn't intend to use monetary policy to try to manipulate the stock market.
"The 1990s have witnessed one of the great bull stock markets in American history," Greenspan told the committee. "Whether that means an unstable bubble has developed in its wake is difficult to assess. A large number of analysts have judged the level of equity prices to be excessive. . . . But bubbles generally are perceptible only after the fact."
Moreover, the bursting of a bubble "need not be catastrophic for the economy," he continued, noting that it wasn't so much the bursting of a U.S. stock market bubble in 1929 or a broad asset-price bubble in Japan a decade ago that damaged the American and Japanese economies, but the poor economic policies each country pursued after the bubble burst.
Greenspan said the Fed should focus monetary policy on maintaining stable prices to foster economic growth, as opposed to trying to prevent a sudden drop in asset prices. As a result, if inflation is not a threat, then the Fed would be free to cut interest rates to offset the impact of a sharp drop in stock prices on the economy, should that occur.
With inflation quiescent -- consumer prices were unchanged last month and up 2.1 percent in the past 12 months -- two Democratic members of the committee, Sen. Paul S. Sarbanes of Maryland and Rep. Maurice D. Hinchey of New York, urged Greenspan not to raise interest rates.
"Current conditions are consistent with containing inflation, and there is no justification for an interest rate increase at this time," Sarbanes argued.
Should Greenspan push for a small rate increase at the policymaking session late this month, according to recent public statements by several of the other officials who will be sitting at the table with him, he will have the backing of most but not necessarily all of them.
The policymaking group, the Federal Open Market Committee, decided at its last meeting to formally adopt a directive indicating that the members expected their next move on rates to be up rather than down because of the sorts of developing imbalances cited yesterday by the chairman. But the committee left the timing of any change uncertain.